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Meaning, Scope & Objectives - Introduction to Cost
Accounting
By: Shilpa Prakash Cost accounting is the process of determining and accumulating the cost of product or activity. It is a process of accounting for the incurrence and the control of cost. It also covers classification, analysis, and interpretation of cost. In other words, it is a system of accounting, which provides the information about the ascertainment and control of costs of products, or services. It measures the operating efficiency of the enterprise. It is an internal aspect of the organisation. Cost Accounting is accounting for cost aimed at providing cost data, statement and reports for the purpose of managerial decision making. The Institute of Cost and Management Accounting, London defines : “Cost accounting is the process of accounting from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centres and cost units. In the widest usage, it embraces the preparation of statistical data, application of cost control methods and the ascertainment of profitability of activities carried out or planned”.
Costing includes “the techniques and processes of ascertaining costs.” The ‘Technique’ refers to principles which are applied for ascertaining costs of products, jobs, processes and services. The ‘process’ refers to day to day routine of determining costs within the method of costing adopted by a business enterprise. Costing involves “the classifying, recording and appropriate allocation of expenditure for the determination of costs of products or services; the relation of these costs to sales value; and the ascertainment of profitability”. SCOPE The terms ‘costing’ and ‘cost accounting’ are many times used interchangeably. However, the scope of cost accounting is broader than that of costing.
OBJECTIVES OF COST ACCOUNTING
There is a relationship among information needs of management, cost accounting objectives, and techniques and tools used for analysis in cost accounting. Cost accounting has the following main objectives to serve:
- Determining selling price
- Controlling cost
- Providing information for decision-making
- Ascertaining costing profit
- Facilitating preparation of financial and other statements
1. Determining selling price: The objective of determining the cost of products is of main importance in cost accounting. The total product cost and cost per unit of product are important in deciding selling price of product. Cost accounting provides information regarding the cost to make and sell product or services. Other factors such as the quality of product, the condition of the market, the area of distribution, the quantity which can be supplied etc., are also to be given consideration by the management before deciding the selling price, but the cost of product plays a major role. 2. Controlling cost: Cost accounting helps in attaining aim of controlling cost by using various techniques such as Budgetary Control, Standard costing, and inventory control. Each item of cost [viz. material, labour, and expense] is budgeted at the beginning of the period and actual expenses incurred are compared with the budget. This increases the efficiency of the enterprise. 3. Providing information for decision-making: Cost accounting helps the management in providing information for managerial decisions for formulating operative policies. These policies relate to the following matters: Determination of cost-volume-profit relationship. Make or buy a component Shut down or continue operation at a loss Continuing with the existing machinery or replacing them by improved and economical machines 4. Ascertaining costing profit: Cost accounting helps in ascertaining the costing profit or loss of any activity on an objective basis by matching cost with the revenue of the activity.
2. Activity-Based Costing: Activity-based costing (ABC) identifies overhead costs from each department and assigns them to specific cost objects, such as goods or services. The ABC system of cost accounting is based on activities, which is any event, unit of work, or task with a specific goal, such as setting up machines for production, designing products, distributing finished goods, or operating machines. These activities are also considered to be cost drivers, and they are the measures used as the basis for allocating overhead costs. Traditionally, overhead costs are assigned based on one generic measure, such as machine hours. Under ABC, an activity analysis is performed where appropriate measures are identified as the cost drivers. As a result, ABC tends to be much more accurate and helpful when it comes to managers reviewing the cost and profitability of their company's specific services or products. Example: Cost accountants using ABC might pass out a survey to production line employees who will then account for the amount of time they spend on different tasks. The cost of these specific activities are only assigned to the goods or services that used the activity. This gives management a better idea of where exactly time and money is being spent. To illustrate this, assume a company produces both trinkets and widgets. The trinkets are very labor intensive and require quite a bit of hands-on effort from the production staff. The production of widgets is automated, and it mostly consists of putting the raw material in a machine and waiting many hours for the finished good. It would not make sense to use machine hours to allocate overhead to both items, because the trinkets hardly used any machine hours. Under ABC, the trinkets are assigned more overhead related to labor and the widgets are assigned more overhead related to machine use. 3. Lean Accounting: The main goal of lean accounting is to improve financial management practices within an organization. Lean accounting is an extension of the philosophy
of lean manufacturing and production, which has the stated intention of minimizing waste while optimizing productivity. For example, if an accounting department is able to cut down on wasted time, employees can focus that saved time more productively on value-added tasks. When using lean accounting, traditional costing methods are replaced by value-based pricing and lean-focused performance measurements. Financial decision making is based on the impact on the company's total value stream profitability. Value streams are the profit centers of a company, which is any branch or division that directly adds to its bottom-line profitability.
4. Marginal Costing: Marginal costing (sometimes called cost- volume-profit analysis) is the impact on the cost of a product by adding one additional unit into production. It is useful for short- term economic decisions. Marginal costing can help management identify the impact of varying levels of costs and volume on operating profit. This type of analysis can be used by management to gain insight into potentially profitable new products, sales prices to establish for existing products, and the impact of marketing campaigns. The break-even point, which is the production level where total revenue for a product equals total expense, is calculated as the total fixed costs of a company divided by its contribution margin. The contribution margin, calculated as the sales revenue minus variable costs, can also be calculated on a per unit basis in order to determine the extent to which a specific product contributes to the overall profit of the company. IMPORTANCE OF COST ACCOUNTING The limitation of financial accounting has made the management to realise the importance of cost accounting. The importance of cost accounting are as follows:
Helps in checking the accuracy of financial account Cost accounting helps in checking the accuracy of financial account with the help of reconciliation of the profit as per financial accounts with the profit as per cost account. Helps in fixing selling Prices It helps the management in fixing selling prices of product by providing detailed cost information Helps in Inventory Control Cost furnishes control which management requires in respect of stock of material, work in progress and finished goods. Helps in estimate Costing records provide a reliable basis upon which tender and estimates may be prepared.
2. Importance to Employees Worker and employees have an interest in which they are employed. An efficient costing system benefits employees through incentives plan in their enterprise, etc. As a result both the productivity and earning capacity increases. 3. Cost accounting and creditors Suppliers, investor’s financial institution and other moneylenders have a stake in the success of the business concern and therefore are benefited by installation of an efficient costing system. They can base their judgement about the profitability and prospects of the enterprise upon the studies and reports submitted by the cost accountant.
4. Importance to National Economy An efficient costing system benefits national economy by stepping up the government revenue by achieving higher production. The overall economic developments of a country take place due to efficiency of production. 5. Data Base for operating policy Cost Accounting offers a thoroughly analysed cost data which forms the basis of formulating policy regarding day to day business, such as: (a) Whether to make or buy decisions from outside? (b) Whether to shut down or continue producing and selling at below cost? (c) Whether to repair an old plant or to replace it?
is necessary to verify their accuracy. This leads to unnecessary increase in workload. It is unnecessary because it involves duplication of work. Some industrial units are functioning efficiently without any costing system. Costing system itself does not control costs. If the management is alert and efficient, it can control cost without the help of the cost accounting.
